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Spain: Continue Reforms to Strengthen Recovery, Create Jobs

Growth expected later this year, but continued reforms needed to spur job creation

Call for prudence in the banking sector

Fiscal consolidation unavoidable, but should be gradual and growth friendly

Spain’s economy is expected to emerge from recession later this year, but the IMF is calling for the European country to continue with reforms to strengthen its economy and bolster job creation.

Speaking to IMF Survey at the launch of the IMF’s regular health check of the Spanish economy, mission chief James Daniel said Spain needed to maintain its recent progress on reforms.

IMF Survey: When will Spain's economy grow again?

Probably later this year, in the fourth or even third quarter. But the really important question is not whether Spain will grow, but whether Spain will grow enough to create lots of new jobs to bring down unacceptably high unemployment, and to increase household incomes.

That’s where the real problem is: we see a recovery, but only a weak one, with growth weighed down by the unavoidable fiscal consolidation and by households and firms dealing with their high debts amid very tight credit conditions. So the government should do everything it can to strengthen the recovery, especially by continuing with their reforms.

IMF Survey: Even if the economy returns to growth, you project high unemployment for several years. What needs to be done to create jobs, faster?

Growth needs to be stronger and needs to become more job rich. That requires action in many areas, including from Europe. But specifically on labor issues, it means increasing wage flexibility so that growth produces more jobs, improving the training of the unemployed and helping them find work, lowering taxes and regulations that discourage hiring, and creating a more even playing field between those with permanent jobs and those with temporary jobs.

IMF Survey: Given the expected weak recovery, should Spain be concerned about the health of its banking sector?

Certainly there is a need to remain vigilant. The clean-up done in 2012 was a thorough exercise and greatly improved the health of the banking system. But risks remain elevated. A key risk is the macroeconomic outlook. If the economy recovers strongly, then banks will benefit, for example, as firms and households can service their debts better. And of course the opposite is also true, if the economy does poorly, so will the banks.

It will also be important for Spanish banks to pass the forthcoming European “stress tests” which are designed to determine whether a bank is strong enough to withstand the impact of adverse developments. So, that is why we call for prudence, such as restricting the amount banks pay in dividends, and for the Bank of Spain to conduct its own exercises on what could be the risks—we’ve been encouraged by the Bank of Spain’s recent actions on exactly these two points.

IMF Survey: Should fiscal consolidation be relaxed further to help the recovery?

Not at this stage, but maybe if the recovery falters. As you know, the pace of consolidation has already been relaxed significantly since last year. The government is now aiming to hit the 3 percent deficit target in 2016 rather than 2014. We think this strikes a reasonable balance between reducing the unsustainably high deficit and supporting growth. But in the future, there should be flexibility on the target if growth disappoints.

Just as important as the amount of adjustment is the type of adjustment. You can cut the deficit in ways that can have greatly different effects on growth. For example, further raising income tax rates or cutting productive spending are much worse for growth than, say, getting rid of tax exemptions and increasing the efficiency of spending programs.

IMF Survey: What should be done about the high levels of private debt?

Private sector debt was in many ways what got Spain into its current difficulties. It is too high and needs to be reduced. The policy challenge is how to make the process of reducing it less costly for jobs and growth. First, more could be done to stimulate growth and jobs in general, so debt-to-income ratios can be reduced more by increasing income rather than by reducing debt. Second, the insolvency regime can be made more efficient, both for firms and households. Third, credit conditions for firms and households could be eased, which is a job both for Europe and Spain.

The IMF Survey welcomes comments, suggestions, and brief readers' letters, a selection of which are posted under What readers say. Letters may be edited. Please address Internet correspondence to imfsurvey@imf.org.